Beginner's guide to 203(k) loans

A 203 (k) Loan is a type of mortgage that can be used to rehabilitate the home you are living in (done as refinancing), or a home you are looking to purchase. You can also rehab a multi-family single-dwelling with a 203 (k) Loan.

203 (k) Loans are offered via the Housing and Urban Development Office (HUD) of the Federal Housing Administration (FHA). The 203 (k) Loan allows a borrower to roll the costs of the rehabilitation into the mortgage as opposed to finding separate financing for your rehab job.

While 203 (k) loans sound like a good idea, the process can be very time consuming and difficult according to Todd Barron, president of Applied Mortgage Services in Northampton, Mass. “In the past 18 months I started the process on six 203 (k) loans and not a single one ended up closing,” said Barron.

What’s good about a 203 (k) Loan

- You can borrow funds (as part of a mortgage) to replace your roof, get a new furnace, weatherize, upgrade your kitchen or bathroom, etc.

- You can use the money to significantly improve energy efficiency, such as installing solar panels for electricity or a hot water system or new windows.

- You don’t need to have a lot of equity in your home.

- You can improve the value of the home you want to buy right off the bat.

- You can correct Title 5 (septic) issues before moving in.

- You can purchase all new appliances for apartments if you have or are purchasing a multi-family house.

- You can add an additional floor or room to the house.

The downside to 203 (k) Loans

First of all, there are fewer and fewer lenders willing to administer this type of loan, so your first problem may be locating a willing lender. The property must then be appraised. The lender can not close on the loan unless the condition and value of the house are thoroughly assessed. The mortgage is based on the projected value of the property once the rehab is completed.

Barron said there are two types of 203 (k) loans, a “full-blown” standard loan and a “streamlined” loan. Barron said his company is moving away from standard 203 (k) loans.

Also, adding the rehab component to your mortgage usually raises the interest rate by about a half-percent according to Barron. “Another half percent isn’t a lot, but it makes it (a 203 (k) Loan) less attractive,” he said.

Barron gave the example of purchasing a $150,000 house and wanting to do $30,000 worth of renovations as being worth-while in terms of a slightly higher interest rate. If you wanted to purchase a $280,000 house and do $20,000 worth of renovations, Barron suggested looking at other loan options such as home improvement loans once you purchase the property. Depending on where you live, there are maximum allowable borrowing limits (prior to renovating) for properties.

Standard 203 (k) Loan

Barron said that one of the most difficult aspects of the standard loan is the requirement to have an appointed plan reviewer in order to have FHA approval. The plan reviewer meets with the customer and determines the scope of work. “The plan reviewer has a lot of power. For example, they may require you to add another $25,000 to the project in order to meet HUD guidelines,” said Barron.

The project reviewer has a lot of control over who is hired for the project (s) and ultimately make the decisions on who to hire based on estimates. The project reviewer does a feasibility study that can take “one day or two to three weeks,” said Barron.

Barron added that the project reviewer does provide protection for the customer in terms of costs and quality of work standards.

Streamlined 203 (k) Loans

Barron said that one of the major differences between a standard and streamlined loan is the maximum amount that can be borrowed is $35,000. “This includes permits, inspection fees, and a ten percent contingency reserve,” said Barron. “So, what you really have is $30,000 to $31,000 for renovation.” Barron said that in the streamlined loan, only specific types of rehab can be done to a property. “You can’t do substantial structural repair,” he said. The plan reviewer in a streamlined loan will allow the customer to seek out estimates themselves and make their own choices regarding which contractor to use.

There are still a wide range of projects that can be done with the streamlined loan, including most energy efficiency improvements.

There are some state-to-state differences that apply to the loans, but most are not usually significant according to Barron.